Corporate Practice
APRIL 2012
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California Creates Two New Types of Corporations
Effective January 1, 2012, there are two new types of for-profit corporations available in California
– the benefit corporation and the flexible purpose corporation. The purpose of these new
corporate entities is to allow for-profit corporations to pursue goals beyond profit-maximization
for shareholders – including environmental and social goals. Traditionally, companies established
for the purpose of benefiting the public would have to be organized as a not-for-profit corporation.
However, not-for-profits do not allow those interested in providing financial support to receive
any financial benefit in return, other than income tax benefits associated with making a donation
to a 501(c)(3) qualified entity. This limitation is eliminated with the new benefit corporation and
flexible purpose corporation structures. Now investors can financially support a company that
benefits the public and share in the financial success of those public interest ventures.
Patagonia Inc., the well-known outdoor apparel manufacturer and retailer, became the first
California corporation to convert to a benefit corporation. Whether or not other companies will
follow is unclear as it is uncertain whether these new entities will provide real benefits to their
adopters and shareholders.
Benefit Corporation
PARIS
California Corporations Code §§ 14600 et seq. provide for the formation and governance of
California benefit corporations. California became the sixth state to recognize benefit corporations
– following New Jersey, Virginia, Hawaii, Vermont, and Maryland. New York recently became
the seventh.
SAN FRANCISCO
How does a company convert into a Benefit Corporation?
NEWARK
SHANGHAI
WASHINGTON, D.C.
www.winston.com
Under California law, an already existing corporation may, through amendment of its Articles of
Incorporation or through a merger, reorganization, or conversion, become a benefit corporation.
If the change is effectuated by an amendment to a corporation’s Articles of Incorporation, then it
must be approved by at least a 2/3 shareholder vote to be effective.
What restrictions apply to a Benefit Corporation?
• Benefit corporations must be formed for the purpose of creating “general public benefit” –
defined by the Code as “a material positive impact on society and the environment, taken as a
whole, as assessed against a third-party standard, from the business and operations of a benefit
corporation.” This concept is relatively abstract, and there is not any clarity as to what will
meet this requirement.
◦◦
The statute defines “third-party standard” as a standard for defining, reporting, and
assessing overall corporate social and environmental performance and provides a list of
requirements for the standards.
▪▪
There are a number of third-party standard organizations that provide third-party
sustainability reporting standards, including the Global Reporting Initiative (GRI),
GreenSeal, Underwriters Laboratories (UL), ISO2600, Green America, and B Lab.
The benefit corporation must determine whether the chosen standard is statutorily
compliant. The standards are usually structured as questionnaires and are usually
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industry specific. It is essential that a company evaluate
any potential standard in order to ensure that its
performance measures are relevant to the company’s
business. For example, it would be inappropriate for an
investment firm to choose a manufacturing standard.
• A California benefit corporation may, in addition to its purpose
of creating a general public benefit, name one or more specific
public benefits in its Articles of Incorporation that shall be
the purpose or purposes of the benefit corporation, including,
for example, improving human health, promoting the arts,
sciences or advancement of knowledge, and preserving the
environment.
• Unlike an ordinary corporation, a benefit corporation’s
accountability extends beyond its relationship with its
shareholders – it is also accountable for its ability to create
(or its failure to create) a public benefit. A benefit corporation
must deliver to each shareholder an annual report that assesses
the corporation’s performance – evaluated against the chosen
third-party standard – in creating both a general public benefit
and, if applicable, any specific public benefits identified in the
Articles of Incorporation.
• It is important to note that actions or claims cannot be brought
against a benefit corporation or its directors or officers solely
for failure to achieve a general or specific public benefit.
Flexible Purpose Corporation
The California Corporate Flexibility Act of 2011 (“CFA”),
California Corporations Code §§ 2500 et seq., provides for the
formation and governance of flexible purpose corporations.
Flexible purpose corporations are a new entity type and do not
exist in any other state. The flexible purpose corporation, like the
benefit corporation, is intended to provide for-profit corporations
with social and environmental goals a vehicle to pursue those
goals without risk of shareholder suits.
What is the difference between a benefit and flexible
purpose corporation?
The chief difference between benefit and flexible purpose
corporations is the relative rigidity of the benefit corporation
structure. The legislative history suggests that the flexible purpose
corporation structure was intended to provide greater protection
to directors than exists under the benefit corporation structure.
To this end, flexible purpose corporations allow for greater
flexibility in choosing a purpose or purposes and are not required
to receive third-party certification of their impact on society
and the environment. Existing corporations can become flexible
purpose corporations by a 2/3 shareholder vote, with dissenting
shareholders having the right to redeem their holdings.
What restrictions apply to flexible purpose corporations?
• The Articles of Incorporation must list the special purposes of
the corporation (any purpose or purposes that could be carried
out by a non-profit public benefit corporation).
• The annual report sent to shareholders must include a
management discussion and analysis concerning the flexible
purpose corporation’s stated purpose or purposes that identifies
the corporation’s objectives relating to its special purpose
or purposes, methods for achievement of the objectives, a
description of the corporation’s process for evaluating its
performance (financial, operating and other measures), and
the corporation’s material operating and capital expenditures
in furtherance of its objectives.
Why would a company consider becoming a benefit or
flexible purpose corporation?
In theory, these new corporate entities should be considered by
any company that is interested in pursuing social or environmental
objectives. A company that is considering pursuing public interest
goals can reduce the risk of shareholder suits for corporate waste
that are common to traditional corporations. The greater the
exposure to shareholder suits for corporate waste, the greater
the appeal of a hybrid structure that affords protection from such
suits. As between benefit and flexible purpose corporations, the
relative flexibility of the flexible purpose corporation likely makes
it a more practical form for any company that wishes to maintain
autonomy over its mission and objectives. For companies with
a clear mission and objectives, the “general public benefit”
requirement and third-party standard evaluation of the benefit
corporation structure may be overly burdensome. Under the
flexible purpose corporation structure, that corporation could
simply state its purpose or purposes in its Articles of Incorporation
and undertake the required management discussion and analysis
in its annual report to its shareholders.
In practice, however, the benefits of these hybrid structures
are likely outweighed by the difficulty in implementing a
clear strategy that can address typical shareholder concerns of
maximizing financial returns on their investment. For a closelyheld company like Patagonia, with a marketing strategy heavilyfocused on environmental concerns, these structures likely serve a
valid purpose. They can further the company’s image as a sociallyconcerned brand without fear of shareholder suits for corporate
waste. But most companies do not fit the Patagonia mold and will
likely find shareholder approval difficult, or impossible, to obtain
since there are few, or no, tangible benefits to a broad shareholder
base.
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What are the risks?
For the board of directors and management, one of the primary
risks of adapting to one of these structures is uncertainty. These
structures are new and untested. Although they are intended to
protect “mission-driven” management from shareholder suits for
corporate waste, the obligations and fiduciary duties applicable to
a benefit or flexible purpose corporation are not clearly defined
and, further, there is no legal precedent to provide guidance. Laws
will be developed by the courts as disputes arise through litigation,
but for now directors and management will have to be cautious
because the statutes do not provide clarity.
For investors, the obvious primary risk is that management’s public
interest goals may overtake their financial interests. It would be
prudent for investors to request a business plan that details the
precise goal metrics that will be used to measure the public interest
goals while at the same time maintaining a meaningful ability to
realize financial gains from the investment. The balance between
the two goals will be at the heart of any discussion.
If you have any questions regarding any matters discussed in this briefing, please contact any of the Winston & Strawn attorneys listed
below or your usual Winston & Strawn contact. Los Angeles (213) 615-1700
J. Anthony Borrego
Jim Levin
Jason Baskind
San Francisco (415) 591-1000
James E. Topinka
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